Hexlant explores the current state and future of decentralized autonomous organizations.
Decentralized Autonomous Organizations (“DAO”s) have garnered attention again with the growth of the Decentralized Finance (“DeFi”) and Non-Fungible Tokens (“NFT”s) market. While DeFi is novel finance and NFTs are the future of the art and gaming, DAOs are called the future of human organization and community.
The DAO refers to an organizational form in which members coordinate their efforts and digital resources based on multilaterally agreed smart contracts. In other words, it is a new organizational structure that can render the entire governance process efficient and reliable through blockchains, from decision-making to operation of systems themselves. In South Korea, the DAO is widely known as a protocol economy model that can fairly distribute among contributors the value and benefits created via the platform.
Generally, the operation period of DAO services can be as short as one year. Nevertheless, the number of DAO players has been increasing rapidly due to the activation of tool services that can build DAOs more easily. The applicable industries are broad and span art, developer support, finance, insurance, education, media, etc.
In addition, the legal validity and governance framework of DAOs have been actively debated in the context of leading actual social change. Several attempts are still underway to resolve insufficient governance incentives such as legal ambiguity of smart contracts, low turnout of global community members, and limitations in attracting funds.
Characteristics of DAOs
The DAO is a decentralized autonomous organization based in the Internet. It conducts supervision through a series of automated rules via self-regulation proposals without the intervention of a centralized entity.
Fig. 1: Differences between DAOs and Traditional Organizations
Sources: dOrg, Stanford University, Hexlant Research
Benefits of DAOs
1) Borderless collaboration
2) Organizational transparency
3) Participatory decision-making
4) User ownership
5) Algorithmic ownership allocation
6) Novel fundraising mechanisms
7) Trustless fund management
2. Structure of DAOs
The DAO’s taxonomy is classified via four key elements: multilateral agreements, resource management, and the discussion and voting processes.
The multilateral agreement is the decision-making process for DAOs to coordinate P2P-based influence instead of the distribution of certain classes. However, in cases where a multilateral agreement is required, natural language texts that explain certain emergency software upgrades or legal contracts may be excluded.
Resource management is one of the main elements since a DAO’s autonomy is closely related to control over allocating and managing resources. The monopoly of on-chain resources (e.g., tokens) can break the balance in the DAO’s multilateral consensus, so smart contracts must be properly implemented. When using off-chain resources like legal tender, individuals and companies have control over the assets, so they must abide by the law.
Aave DAO Governance - Proposal to add Fireblocks LLC as a whitelister
Due to the nature of the DeFi system, it was unknown to whom the lender was lending but through the whitelist registration, Aave Governance ensures that users of these approved lending pools comply with relevant laws depending on the jurisdiction of the user.
Aragon Budget DAO
The Aragon Budget DAO provides visibility into a DAO’s token allocation, voting, financial execution, and additional payments. It also secures transparency of funds so stakeholders can track down a bill of expenditures. In addition, the semi-annual transparency report1 provides further information on legal currency and other platform expenditures that cannot be confirmed through Budget DAO. (Transparency Report, p. 33)
Discussion and voting lead to resolutions for how the majority can achieve the other key elements above. The smart contract execution implements these official processes transparently. Forums and messenger discussions held arbitrarily off-chain are also possible. In this case, when a rough agreement is reached in the proposal discussion, on-chain consensus can be achieved by switching to chain-based voting.
After submitting a grant proposal by referring to GitHub, the DAO will review the proposal. At this time, if DAO members believe that the proposal needs to be reviewed, they will submit it to the Grants page and discuss the feasibility of the proposal with community members, without the need to vote for two days. After the grace period, the DAO will vote on approval of the proposal.
Each DAO has a dedicated voting method based on a transferable floating stake. This staking token can be a basic token or an external token. Additionally, weights may be applied to tokens that have not yet been transferred due to other categories (such as reputation rather than equity). If voting is conducted based on the account address, each person can exercise n votes, so sustainable guidelines such as Know Your Customer (KYC) rules need to be considered.
The goal of the DAO is to encourage people to achieve shared common missions while navigating through their governance. To form a DAO, four decisions need to be made. 1) Allocation of resources and funds 2) Issuing new shares 3) Providing services 4) Managing external systems.
Fig. 2: DAO Mechanism
Sources: dOrg, Stanford University, Hexlant Research
History of DAO
In 2016, The DAO, a platform for investor-centered venture capital, caused an Ethereum hard fork as it lost $60 million of ether by a smart contract reentrancy attack only two months after it had been launched. Despite its short lifespan, it has inspired DaaS, a system to promote DAO distribution as in Aragon, DAOStack, Colony, various MolocDAOs, and MetaCartel.
After the failure of The DAO, players raised funds with initial coin offerings representing DAOs in 2017. Most of them failed before establishing decentralized governance.
In 2018, DAO frameworks like Aragon, DAOStack, and Colony appeared. Those DAO frameworks focused on designing permission to securely connect a wide range of modules through voting, building transaction delivery systems, and figuring out problems of distributed decision-making processes.
The Appearance of Early Market Suitable Products
Finally, successfully running services on the market emerged in 2019. There are non-profit DAOs like Moloch, a web3 development collective dOrg, DeFi insurance protocol Nexus Mutual, etc. Some of them tried some projects to attain legal status.
The DeFi Explosion
In 2020, popularized liquidity mining and governance tokens appeared. Compound, Uniswap, MakerDAO, Synthetix, Aave, Yearn, Sushiswap, and Badger are DeFi DAOs.
NFTs, known for their nonfungible scarcity, have been subject to an investment limitation as it is difficult to assess an NFT’s value objectively due to the lack of evaluation indexes. As a result, the Venture DAO model, which enables joint investment, has been drawing keen attention alongside the growth of the NFT market. Members of the DAO conduct deal sourcing and screening processes conducted by existing capitalists based on the smart contract. It is a form of decision-making with the power of collective intelligence, joint investment, and distribution of profits. As the number of such NFT DAOs increases, it is expected that standards for the proper evaluation of NFTs will be established.
Example of a DAO’s Architecture
The architecture of a DAO can be described as consisting of the underlying protocol layer, service and middleware, and decentralized application layer. Let us look at the basic technology stack required for a DAO through DAOStack architecture.
The underlying protocol layer can choose between on-chain governance or off-chain governance. On-chain governance refers to the form in which governance is performed within the chain without any elements other than blockchain network components, as seen with Decred, Tezos, and Polkadot. This method includes developers, users, and miners voting on blockchains to modify policies. Off-chain governance is an informal discussion model that convenes outside of the network but still affects internal networks, as seen with Bitcoin Improvement Proposal (BIPs) and Ethereum Improvement Proposals (EIPs).
DAOStack utilizes the Arc library and infra library based on the Ethereum mainnet. These two libraries include universal contract functionality such as DAO smart contract address and assets, DAO tokens, the DAO’s authority (assigning reputation to members, upgrading DAO contracts, adding new functions or deleting them, etc.), restriction of authority (limiting fund use per proposal and maximum reputation scores of users), DAO access constraint and more. Although there is an element of managing the voting machines that perform voting and the distribution of voting rights, DAOStack uses reputation-based voting rights.
Middleware & services can be divided by service aggregation (ex. Snapshot) and tools that help to create the DAO (Aragon, DAOStack, subDAO). Snapshot is a tool for making proposals off-chain and providing flexibility in voting and calculation methods. It also allows the proposals and voting of several DAO services to proceed in one place. Among DAO tools, the DAOStack protocol helps to easily build distributed governance for submitting proposals, granting votes, sharing proposal, executing results and managing user reputation. Aragon distributes DAOs and provides governance establishment, verifiable centralized voting, dispute resolution, and decentralized voting solutions as independent services.
Fig. 3: Aragon DAO OpenStack
* Govern, Voice, Court are interoperated
The decentralized application layer is divided into financing and business decision-making types according to the use of governance tokens. Two of the most representative financing DAOs are The DAO and Moloch DAO. There is also MakerDAO, wherein people participate in business decision-making.
DAOStack distributes new DAOs through Alchemy and provides votes and suggestions by exploring existing DAOs.
Fig. 4: Composition of DAO through DAOStack Architecture
Sources: Hexlant Research, Nodesblock, DAOstack
Fig. 5: Comparison of Ethereum DAO Projects
Sources: Messari, Hexlant Research
The DAO ecosystem was divided into developer support funds, venture DAO, DeFi DAO, decentralized governance, protocol, DaaS. In recent years, the application fields have become more extensive, subdivided into social network types, metaverse, and asset management.
Fig. 6: DAOs Service Categories and Brief Introduction
Sources: Hexlant Research, Aragon, DeepDAO (21.9.30),
“DAO” is the term for an organization operated by recorded rules in smart contracts. Its meaning has been established in the blockchain space, yet it is necessary to examine to what extent DAOs will be recognized.
1) D- Decentralized
This question is whether decentralization should be established only at the infrastructure layer, which is a blockchain-based network, or whether decentralization should be implemented in governance that should not be controlled by certain participants or groups.
2) A – Autonomous
The required level of autonomy and automation varies depending on the degree of human intervention, whether there should be none or the DAO is operated with the participation of members but should not depend on a small number.
* Wyoming DAO law defines a DAO as a member-managed or algorithmically managed organization. According to the amendment, a DAO should specify the scope of management to which the algorithm is applied and how it is managed by members in the Article of Association. The algorithmically managed DAO should allow smart contracts to modify and upgrade updates.
3) O – Organization
There is the question of when a community that interacts with smart contracts is considered an effective organization. For example, whether a simple act of trading based on a smart contract corresponds to organizational activity or active participation, such as a governance model or collective interaction between participants, defines the DAO. In the former case, there is no subject to regulate. However, in the latter case, the matter of the corporate status of the DAO and the separate recognition of a corporation that operates the DAO and the DAO itself become crucial factors in determining whether people who participate in DAO activities can be protected from liability.
Various attempts are being taken to ensure the legal status of the DAO to reduce the risk of ambiguity in its legal status. DAOs expose members to liability for all actions and obligations of a DAO when it is considered as a general partnership. Therefore, a bill was passed to provide liability protection for members such as contract developers who did not participate in the DAO and its operations but only wrote code.
Compound overpaid $900 million due to an update error
Due to an error in the update of the Compound payment contract on September 29, 2021, Compound erroneously paid users an additional 89 million dollars in Compound tokens ($28 million $COMP). There were also ethical disputes about whether users who accidently received this jackpot were obligated to return $COMP, and whether Compound Labs was eligible to take legal action to collect $COMP.
In April 2021, the State of Wyoming in the United States passed a DAO bill that allows DAOs to be granted legal status based on smart contracts. In the same month, SEC member Hester Peirce announced a token safe harbor proposal 2.0, providing a three-year grace period before deciding whether to provide securities to the token project.
State of Wyoming’s DAO Law
While banning lawsuits that treat DAO as general partnerships, state courts enforce a DAO’s rights as a corporation, so DAO developers are not subject to legal responsibility by the simple establishment of a DAO.
Securities Law Applied to DAO Tokens
In 2017, the US Securities and Exchange Commission issued an authoritative explanation in an investigation report that DAO tokens correspond to securities under the Securities Act of 1993 and the Securities Exchange Act of 1934. Even though the token issuance is based on distributed ledger or blockchain technology, the current law should be applied because of the nature of the DAO and ICO issuance methods.
In July 2021, a bill was imposed in Wyoming to officially allow decentralized autonomous organizations that have not been defined by existing laws. Now, DAOs can register as a corporation, and a limited liability company can convert to a DAO. DAO is denominated as DAO, LAO, DAO LLC, etc. The DAO follows LLC legal precedents in governance, tax, and dispute resolution.
American CryptoFed DAO, the first Wyoming DAO corporation
American CryptoFed DAO, which uses the EOS blockchain platform, is the first decentralized autonomous organization in Wyoming. It utilizes an unlimited issuance algorithm coin “Ducat” and governance token “Locke” with 10 trillion coins in circulation.
However, it is unclear whether the DAO recognized in Wyoming will be able to maintain the same legal status in U.S. federal courts. In addition, it is unknown whether an organization managed by a DAO will rely on this law. Still, we can discuss a more in-depth regulatory framework based on the DAO law. Considering the wide range of governance implemented by DAOs, we hope that there will be precedents to solving the DAO’s unique problems beyond the application of existing regulations, thereby expanding regulatory awareness of blockchain.
Fig. 7: Comparison of the Legal Status of Limited Liability Companies in Wyoming and Delaware
Sources: Messari, Hexlant Research
Through the DAO’s mechanism, common economic goals are shared, but also shared are risks and rewards with unknown people. Hence, arbitrator groups are established to settle disputes and threats. Such group have neither control nor decision-making power. The members can be elected by other community members, and re-election or exclusion can be determined also by community support after certain activities. In some projects, developers may join the group in the early stages.
They conduct risk assessments and present amendments on market indicators such as smart contract security (code audit), Oracle compatibility, market liquidity, asset governance, and legal issues on behalf of the community for submitted protocol proposals. Arbitrator groups consist of technology experts (smart contract, Oracle, security), economy (market risk, token design, insurance, financial reporting), laws & regulations (security law, property law, hard assets). Communities can achieve common goals more safely with them.
Anyone in the world can access and act as a member of DAOs, and members exercise their voting rights for risks and rewards. Various voting methods have been attempted, possibly based on the reputation or the number of governance tokens obtained through an activity, such as weighted voting and square voting. Wyoming DAO law includes basic rules for voting rights. The revised bill indicates that each member is entitled to one vote in a DAO that does not require contribution of digital assets as a prerequisite to be a member. Thus, members will have equal voting rights for basic proposals of DAOs, such as the dissolution of a DAO.
The DAO is a new organizational form that manages and navigates activities through a smart contract. Anyone can participate in a DAO where it discloses the activity data transparently to the public, which indicates the fairness of results. The result of voting is trackable since a smart contract necessitates that the agreement is implemented in each DAO. In addition, the whitelist allows identification of the members and counterparties of the transaction. Such interactions between DAOs, verification, and expansion to external data, are all mechanisms that embody trust in the digital age.
Through these mechanisms, future DAOs will possess the power of predictability and sustainability. DAOs can transparently confirm that the activities of community members are reasonable decisions and move forward according to the common interests and intended direction. To fully operate the system, risk management must be supported in order to protect all participants. This includes security technology, finance reporting to expand economic and regulatory awareness, and the application of legal and institutional devices. Furthermore, for the maturation of DAOs, incentive measures to address low turnout and limited usage of governance tokens should be improved.
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Laila Metjahic, Deconstructing the DAO: The Need for Legal Recognition and the Application of Securities Laws to Decentralized Organizations, Cardozo Law Review, Volume 39 Issue 4
Admin of NODESBLOCK, In-depth analysis of the development process and prospects of DAO on the chain, NODESBLOCK, (May 23, 2021), https://nodesblock.com/news/in-depth-analysis-of-the-development-process-and-prospects-of-dao-on-the-chain/
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Michael Dill, Crypto, DAOs, and the Wyoming Frontier, JDSUPRA, (Jul. 20, 2021), https://www.jdsupra.com/legalnews/crypto-daos-and-the-wyoming-frontier-9251606/
dOrg, Stanford BioE 60: Beyond Bitcoin - Decentralized Autonomous Organizations (DAOs), Stanford University, (Mar. 15, 2021), https://www.youtube.com/watch?v=SYPzqRaN4zA
Mason Nystrom, DAO-off: Moloch vs. DAOstack, Messari, (Jul. 3, 2020), https://messari.io/article/dao-off-moloch-vs-daostack
WY Stat, Enrolled Act No. 73. Decentralized Autonomous Organizations, (Apr. 21. 2021), https://www.wyoleg.gov/Legislation/2021/SF0038